CB, Treasury harmony freed Sri Lanka from vicious cycle trap to virtuous cycle: Cabraal

Wednesday, 28 August 2013 01:05 - - {{hitsCtrl.values.hits}}

Governor Nivard Cabraal last night made a compelling case that the close cooperation and relationship between the Central Bank and the Ministry of Finance led to the creation of what he described as a virtuous cycle, aiding the rapid and sound socioeconomic growth in the country. “The harmonisation between the monetary and fiscal policies during the past seven years has led to the creation of a new ‘virtuous cycle’ for sustained growth as opposed to a ‘vicious cycle’ of interconnected economic ills in previous years,” Cabraal said, during the delivery of the 18th Annual Tax Oration of the Chartered Institute of Sri Lanka yesterday.

To illustrate the degree of harmonisation that took place between the policies of the Central Bank (CB) and the Ministry of Finance (MOF), to deliver some of the vital results to the country and economy, Cabraal also briefly shared seven case studies (see box) during the oration at which Economic Development Minister Basil Rajapaksa, Finance Secretary Dr. P.B. Jayasundera, Chief Justice Mohan Peiris and local heads of the World Bank, ADB and IMF were also present. He described the virtuous cycle of having low inflation leading to real interest rates; real interest rates leading to enhanced savings; enhanced savings leading to a regular pipeline of investment; regular investment leading to lower debt levels; lower debt levels leading to sustained growth; and sustained growth once again leading to low inflation. His description of vicious cycle included high fiscal deficits leading to high inflation; high inflation leading to high interest rates; high interest rates leading to low investor confidence; low investor confidence leading to sluggish investment; sluggish investment leading to low growth; low growth leading to high debt; and high debt once again leading to high fiscal deficits.

“This was the vicious cycle that we had been trapped, for more than five decades since independence,” Cabraal said, adding, “What was worse was that there was almost a sense of acceptance of such performance among many officials of both the MoF and CB, who harboured the internal view that it may be our country’s ‘karma’ to have low growth, large fiscal deficits and high inflation.” “In fact, many Central Bank officials were often heard to lament that the continuous high fiscal deficits of the Government was pushing inflation up and grumble that the Government will never stop doing that. In turn, MoF officials used to complain that the tight and insensitive monetary policies of the CB were the root cause for the fiscal deficit always being out of control,” quipped Cabraal. In that context, Governor said it was clear that a change in attitude and a change in action were vital at both Central Bank and Ministry of Finance leading to collaboration which the Monetary Law Act provides for and founder of Central Bank John Exter had articulated clearly. “It was also necessary to make some effective interventions to change the equilibrium of this vicious cycle, so that a fresh equilibrium could be created. We (CB and MOF) decided that we would take the necessary initiatives to improve investor confidence so as to ensure the continuous investment via the Government and the local private sector, whilst specifically targeting new foreign investment. Accordingly, many initiatives were implemented, and over a comparatively short period of time, such efforts started showing results,” Cabraal said, in addition to highlighting some key achievements of the Government led by President Mahinda Rajapaksa since 2005. Given this success, the CB Chief said Sri Lanka has been able to break free from the previous vicious cycle, and place the country on a more virtuous cycle. Major incidents of harmonisation between Ministry of Finance and Central Bank

Case Study 1: Opening out Sri Lanka Treasury Bills and Bonds to foreign investors
Case Study 2: Debut International Sovereign Bond
Case Study 3: Intervention to stabilise a systemically important bank
Case Study 4: The creation of our present day “virtuous cycle”
Case Study 5: The establishment of the Deposit Insurance Scheme
Case Study 6: Stabilisation measures of 2012
Case study 7: Judicious use of fiscal policies, based on inflation behaviour and other macro-economic factors

Going forward, he said the challenge would be to carefully nurture and guard this new equilibrium, knowing fully well that the disturbance in even one of those components could change that situation with adverse results. He also said both the CB and MOF were determined to implement credible and effective policies through a harmonised approach that is designed to take the country forward. “I would also argue that, for such approach to be successful in the long term, we must always retain one of the most important features of our current economic management, which is that the MoF and CB must have a ‘shared’ vision and ‘shared objectives’. That shared vision has been the platform that has helped the two institutions to achieve ‘goal congruence’ in the recent past, and there is also no doubt that the resulting harmonisation has been the powerful driving force behind our steady progress,” Cabraal said. During his oration, the CB Chief, who was a former President of the Chartered Accountants, also recognised the contribution of the private sector and professionals towards ensuring sustained growth between 2006 and 2013 and emphasised that their contribution has been a vital factor in maintaining the momentum and thrust of our economy. “No amount of harmonisation of Monetary and Fiscal policies could ever be a substitute for the commitment and dedication of a vast number of entrepreneurs who take risks, as well as burn the midnight oil, to deliver value in our economy,” Cabraal stressed.